Financial Progress Notes
In theory, you would think that the subject of life insurance would be a fairly cut and dry subject. However, once you think about what it is for, who it is for, the strategies described (ie. wealth transfer, business insurance, executive benefits), and the philosophical views (just buy term and invest the difference), you find you could be dealing with an emotional and thought provoking topic.
This is a brief overview on a principal component of financial planning. It is one that is not necessarily static, as the economics of our personal and business lives do change. If you have loved ones who depend upon your income, your assets, or your ability to fulfill financial obligations, then you have a good case to evaluate life insurance. Consider some of the following benefits personal insurance can provide.
- Pay mortgages or other debts
- Income replacement
- Accommodate Self-Completion of Financial Goals – Education, Supplement Retirement
- Settle estate, income, and capital gains taxes
- Provide balance in inheritances among heirs
- Fulfill charitable intent
There really is no other tool like life insurance. You can set aside relatively few dollars and create hundreds of thousands or more of tax free dollars; available immediately. The only downside is you have to pass for others to receive the maximum benefits! In 2001, updated mortality tables in the industry became the catalyst for cost efficiencies, pricing innovations, and new designs. The lower overall cost of insurance can be seen in both term and permanent cash value policies. These new designs may now potentially produce higher levels of tax-free access to the insured during life before beneficiaries receive their benefits.
This is not to say that permanent, or cash value life insurance is appropriate in all cases. I know I have read in other physician blogs that you should only buy level term coverage for the longest term given your age. This type could be the most appropriate in many cases. However, there are a number of variables to look at in an entire plan that may favor different designs, and they should be reviewed. Just as there might be variations in treatments for a specific cancer with different patients, each case should be evaluated on its merits, objectives, and financial conditions.
It is somewhat interesting to note most beneficiaries never see the death benefits from term policies. This is not due to the viability of insurance companies. A Penn State University study completed in 1993 found that only 1% of all term insurance resulted in death claims. Essentially, only 1% of all term policy owners actually keep their coverage past 15 to 20 years. 1
So let us review some of the different types of coverage. We are assuming one is insurable, aside from variances in ratings due to various health conditions. If there is a particular protection need for a targeted length of time, term life insurance can provide this at an affordable cost. If one is looking for a very short period up to five years, annual renewable term could be an option. This can give the lowest initial cost, but premiums will increase each year.
For most applications in term, where you are looking at 10, 15, or 30 year periods (depending on age), you would be looking at level term. This provides the least cost and cash outlay over longer periods, as premiums are amortized over the specified period, based on the initial age of the insured.
What kind of objectives would this approach be a good fit for? It could cover exposure to mortgage loans and business loans. When you have minor children, you can have resources to cover child care and college expenses. Perhaps you have a medical group practice with various forms of ownership. This could fund buy/sell agreements or cover key man insurance for a valued employee.
Of course, there are even variations on this simple concept. With level term, if you do not pass during this period (the preferred scenario!), or convert to a permanent type of coverage, the insurance would expire. Yes, the insurance company will have kept all of your premiums during this coverage period. (Just like your auto insurance). If you are willing to pay higher premiums for the insurance period, there is another design known as Return of Premiums or ROP. In this instance, if you don’t pass during the coverage period, the insurance company will return all the premiums paid. This is not as popular because the premiums are significantly more (ie. 30% more). Conceivably, you could be investing this extra premium over the term. Proponents will say you could use the returned funds for retirement, convert and buy a reduced paid up permanent policy, or have achieved some objectives (like a buy/sell agreement) at zero net cost at the end of the term. Clearly, this would need to be reviewed.
If the objective is to have some level of lifetime coverage, then it would make sense to entertain permanent, cash value life insurance. There are a number of different types, and we won’t delve deeply into this topic at this time. However, you will likely recognize names such as Whole Life, Universal Life, and Indexed Universal Life among the fixed cash value types. Here, lifetime planning goals, where you don’t want an “end” coverage date, or you don’t know when an end date could pass your coverage date, may include:
- Debt liquidation obligations such as personal or business mortgages, and business loans for expansion
- Protection for minor children to cover college expenses and care
- Business coverage to fund buy/sell agreements between partners, or key man insurance
- Estate Planning strategies to effect estate preservation, charitable intent, or even creating an estate for heirs
- Supplement retirement income tax-free by accessing cash value (withdrawal to basis), and/or loans against cash value
- Provide Long Term Care coverage with tax free benefits through product design, or additional riders
In practice, well designed cash value policies have produced significant accumulation, income, and death benefits. Much of this performance can be linked back to better mortality rates. This factor has effected underwriting considerations, and has led to new designs and innovations in crediting interest. However, the design still has to match up with financial objectives and resources. These are some of the developments that have taken place that have influenced both the term and permanent insurance marketplace.
Secondary Guarantees with No Lapse Provisions: Minimum premium levels keep a premium in force despite interest crediting
More Rate Classes available: ie. Not just preferred and standard, but preferred plus and standard plus type ratings can translate into overall better premium rates
Table Shave Programs: Carriers may offer a better rating under certain conditions: ie. a Standard with a lower “Table 2” rating may receive a Standard rating. Again, the result is a better premium rate
Tobacco/Cigar Use Reviews: These may have quit smoking incentives, which may result in lower premiums
Living Benefits Riders (ie. Long-Term Care, Wellness): In the effort to solve the looming long-term care issue, some designs offer riders added to cash value type policies for an additional premium. In the event of long-term care activation, the death benefit is accessed early. Beneficiaries receive any remaining death benefit value. If all the death benefit is used, a rider may provide additional long-term care benefits.
Wellness riders promote good health and periodic checkups. If regular checkups are documented, this can result in greater credits or reduced premium over time in a policy
As you can see, there are a number of variables and goals to consider when designing a life insurance program. There are cases for example where buy term, and invest the difference could be effective and appropriate. In other instances, one’s objectives and profile may dictate a different approach. It is certainly worth planning to see the effect of coverage on your lifetime cash flow.
1 Personal Equity Institute. Classrooms – Educational Articles. http://peiwealth.com/pei-classroom-4.aspx